Minutes of the Monetary Policy Meeting of the Reserve Bank Board

Hybrid – 3 October 2023

Members participating

Michele Bullock (Governor and Chair), Ian Harper AO, Carolyn Hewson AO, Steven Kennedy PSM, Iain Ross AO, Elana Rubin AM, Carol Schwartz AO, Alison Watkins AM

Others participating

Brad Jones (Assistant Governor, Financial System), Christopher Kent (Assistant Governor, Financial Markets), Marion Kohler (Acting Assistant Governor, Economic)

Anthony Dickman (Secretary), David Norman (Deputy Secretary)

Andrea Brischetto (Head, Financial Stability Department), Penelope Smith (Head, International Department), Tom Rosewall (Acting Head, Economic Analysis Department), Carl Schwartz (Acting Head, Domestic Markets Department), Meredith Beechey Osterholm (Deputy Head, RBA Future Hub)

International economic developments

Members commenced their discussion of the global economy by observing that high inflation remained the key challenge facing central banks around the world. While core inflation had gradually moderated in most advanced economies in year-ended terms, monthly observations had edged higher in the United States and Canada. The persistence in core inflation had been driven by core services prices; core goods price inflation had moderated, and prices had declined in the United States and the United Kingdom over preceding months. Rising energy prices had seen headline inflation pick up in a number of countries over the prior couple of months, including in Australia. Members discussed the recent increase in oil prices, which were almost 30 per cent higher than at the end of June. The increase had occurred mainly in response to the decision by Russia and Saudi Arabia to extend supply cuts to the end of the year. Refined fuel prices had risen even more, owing to an increase in refinery margins following production disruptions in some markets.

Members noted that output growth in advanced economies had slowed in response to contractionary monetary policy settings and cost-of-living pressures. Conditions in the manufacturing sector remained weak. While conditions in the services sector had been more positive for much of the year, they had eased in some advanced economies over prior months. By contrast, the US economy had shown considerable resilience, including in household consumption. Across advanced economies, slower output growth had been reflected in a gradual easing of tight labour market conditions. Unemployment rates had edged up but remained low, and job vacancies remained at high levels.

In China, the most recent indicators of economic activity had been somewhat more positive than in prior months. Members observed that the property market remained the key exception; real estate investment, new housing starts and housing prices had all declined further over the preceding month. In response, Chinese authorities had implemented further modest policy stimulus measures targeted at the property and household sectors as well as infrastructure investment. A material slowdown in the Chinese economy remained a key risk to the global outlook.

Despite the weakness in the property sector, Chinese steel demand had been resilient owing to ongoing demand from infrastructure and manufacturing investment. This had helped to support iron ore and coking coal prices. Coking coal prices had also benefited from solid demand from India and some supply disruptions in Australia.

Domestic economic conditions

Turning to the domestic economy, members noted that inflation had continued to moderate from its peak late in 2022. However, as was the case abroad, progress on reducing headline inflation had been temporarily delayed by higher fuel prices. The monthly CPI indicator had picked up in August. Nonetheless, headline inflation was still expected to decline over the second half of 2023, given the earlier slowing in growth in demand – particularly in the household sector – and the further decline in goods price inflation.

Excluding volatile items and holiday travel, inflation had continued to ease in year-ended terms. That said, inflation remained high across a range of services. This reflected a still-high level of demand and a range of domestic cost pressures, including for labour (given both solid wages growth and recent poor productivity outcomes). Electricity prices increased to a smaller extent than had been expected in August, partly due to the contribution from the large increases in default market offers that came into effect in July being less than expected.

Members noted that the monthly pace of increases in rents had been broadly stable over preceding months, though rent inflation had continued to pick up in year-ended terms. Conditions in the rental market remained very tight but had eased somewhat; rental vacancy rates had increased in some capital cities, but remained at very low levels, and growth in advertised rents for new leases had slowed, particularly in regional areas. Together with the current low level of new housing starts and completions, relative to population growth, the still-tight conditions in the rental market suggested that rents would be an ongoing source of inflationary pressure over the year ahead.

Members discussed recent developments in wages and the associated risks. Timely indicators suggested that the large increases in minimum and award wages were flowing through to aggregate wages as expected and had at least partly been offset by some moderation in growth in non-award wages. Members noted that there were few signs of the risk of a price-wage spiral materialising. Some moderation in wages pressures for certain occupations was consistent with an easing in labour market conditions, though the labour market remained tight overall. Even so, aggregate labour costs had increased strongly over the prior year; combined with poor productivity outcomes, this had resulted in strong growth in unit labour costs. Measured labour productivity had declined and was back to its level recorded in 2015.

Members observed that the labour market had reached a turning point as labour supply had picked up and labour demand had moderated. The unemployment rate remained at 3.7 per cent in August, slightly above the 50-year low of 3.5 per cent. Underemployment had risen a little more noticeably, as had the youth and medium-term (those unemployed for 1–12 months) unemployment rates. It was noted that these measures of spare capacity tend to be more responsive to economic activity than the aggregate unemployment rate. Members also discussed hours-based measures of spare capacity in the labour market, as hours worked by current employees are often a key margin of adjustment as conditions in the labour market soften. Hours-based unemployment and underemployment rates had both ticked up in recent months from their lows reached in late 2022. Business surveys and information from firms in the Bank’s liaison program had showed an improvement in labour availability. Voluntary turnover rates had also declined, though finding suitable workers continued to be difficult. Similarly, job vacancies had fallen from their peak in 2022 but remained high.

Members noted that the Australian Government had released its employment white paper, outlining the Government’s objective for ‘sustained and inclusive full employment’. ‘Sustained’ full employment referred to employment being as close as possible to the current maximum sustainable level of employment without causing inflation to rise. This is consistent with the Bank’s existing mandate to maintain full employment. The white paper emphasised the importance of monitoring a broader set of indicators beyond the unemployment rate, which is also consistent with the Bank’s existing approach to analysing conditions in the labour market.

Output growth in the first half of the year had been more resilient than expected. GDP expanded by 0.4 per cent in the June quarter, though GDP and household consumption both continued to decline in per capita terms. Domestic demand had been stronger than expected, as strong growth in business investment and public investment had more than offset weak growth in household consumption in the quarter. There had also been modest upward revisions to GDP in the preceding few quarters, leaving year-ended GDP growth around ½ percentage point higher than forecast in August. Timely indicators suggested that output had continued to grow modestly in the September quarter.

Strong growth in business investment had been underpinned by rapid population growth and high capacity utilisation. Members noted that non-mining business investment had again surprised on the upside in the June quarter, and growth over the first half of 2023 was the highest since 2007 (excluding the COVID-19 pandemic rebound period). Members discussed how deepening the capital stock should, over time, help to lift labour productivity. Even so, some of the recent strength in investment represented catch-up from earlier supply chain disruptions that had been resolved.

Real household disposable incomes had declined by 3 per cent over the preceding year, as strong growth in nominal aggregate labour income had been more than offset by high inflation and rising tax and net interest payments. This had resulted in a period of weak growth in household consumption, including a decline in per capita terms. Despite the uneven effects of higher interest rates on disposable incomes, disaggregated data on spending by income and mortgagor status suggested that the consumption response had been broadly comparable across most groups. Timely indicators of household spending suggested that consumption growth remained weak in the September quarter.

Members observed that the turnaround in the established housing market had continued in recent months. Upward revisions to earlier data meant that nationwide housing prices were only slightly below their April 2022 peak. New listings had also picked up in Sydney and Melbourne, though they remained low in most other areas. Members noted that the stronger-than-expected recovery in the established housing market might provide some support to household consumption in the period ahead.

International financial markets

Members commenced their discussion of international financial markets with an assessment of monetary policy settings in advanced economies. Most central banks had communicated that policy rates were restrictive and that future decisions about policy tightening would depend on incoming data and the outlook for economic activity and inflation. A number had highlighted that lags in the transmission of monetary policy meant that the full effects of previous policy tightening on economic activity and inflation were yet to be seen. Several had noted that the risks to the outlook had become more balanced with policy rates at current levels. Market participants now assessed that policy rates in advanced economies were close to their peaks but their expectations for rate cuts had been pushed back until mid-2024 at the earliest. Markets also expected smaller rate cuts from that point, given the ongoing resilience in economic activity and labour market conditions.

Longer term government bond yields had increased further in most advanced economies, to reach levels not seen since prior to the global financial crisis. Yield curves had also become less inverted, and in Australia the yield curve had steepened slightly. Members noted that the increase in longer term government bond yields had been driven by real yields, while market-based inflation expectations remained steady between 2 and 3 per cent in most advanced economies. Members observed that longer term yields had risen by more than could be explained by changing expectations for policy rates and that estimates of term premia had therefore increased, particularly for the United States. Factors that were potentially contributing to increased term premia included uncertainty around the economic and policy outlook, expectations of a larger effective supply of US Government bonds associated with increased debt issuance in the United States, and reductions in asset holdings by central banks.

Changes in private sector financial conditions in advanced economies had been mixed over the preceding month. Corporate credit spreads had risen slightly but remained around their long-run average in Europe and the United States, and corporate bond issuance had increased, consistent with expectations of a ‘soft landing’ for economic activity. However, equity prices in major markets and in Australia had declined alongside higher government bond yields. While equity prices had generally remained higher than at the start of the year, price gains had been concentrated among technology stocks.

In China, private property developers remained under extreme financial stress, and their bond and equity prices had fallen further in September despite stronger-than-expected economic data and the announcement of additional support measures. The authorities had continued to take measures to stem the pace of depreciation of the renminbi, which had reached levels close to multi-decade lows.

The Australian dollar had depreciated against the US dollar in preceding months, alongside a broad-based appreciation of the US dollar as US Government bonds yields had risen. Concerns about the outlook for China’s economic growth had also continued to weigh on the Australian dollar. However, on a trade-weighted basis, the Australian dollar was only slightly lower than at the start of the year. Members observed that the trade-weighted exchange rate is the relevant measure for imported inflation in Australia.

Domestic financial markets

Members noted that total credit growth had stabilised around its post-global financial crisis average, having declined from its recent peak. While total credit growth was around average, the stock of credit had declined as a share of nominal GDP by around 10 percentage points since early 2021. Accounting for household offset accounts, the household credit-to-GDP ratio was at its lowest since the early 2000s, as was the ratio of business credit to GDP.

Required mortgage payments had increased to 9.9 per cent of household disposable income in August, a little above the previous estimated historical peak. Members noted that required mortgage payments were expected to continue to increase as borrowers with fixed-rate loans roll off onto higher rates. Since the start of the year, cumulative extra mortgage payments into offset and redraw accounts had been below the pre-pandemic average and well below pandemic levels, consistent with pressures on disposable incomes from higher interest rates and the rise in the cost of living.

Members noted that repayment of the first tranche of the Term Funding Facility (TFF) had passed smoothly. This comprised around $80 billion due by the end of September, out of total funding of $188 billion under the scheme. There had been an earlier rise in short-term money market interest rates as issuance by banks had picked up for a time to facilitate this process, but the rise had been transient.

Members observed that market expectations for the cash rate had risen a little in September but remained lower than a few months prior. Prevailing pricing implied that the cash rate was assessed to be near its peak; in particular, market participants expected no change in the cash rate in October, and potentially one further rise in the cash rate by early 2024. By contrast, pricing in July had implied an expectation of as many as three further increases in the cash rate. Market economists’ expectations had also declined since July, with most expecting either no change over coming months or, at most, one further increase.

Financial stability

Members discussed the Bank’s regular half-yearly assessment of financial stability risks. They noted that global financial stability risks were high. However, the core of the international banking system remained well placed to deal with the challenging environment, given low levels of overall loan arrears and high levels of capital and liquidity, particularly among large global banks.

Members discussed the stress in China’s property sector, particularly among private developers. They acknowledged the potential for this to interact with other long-running macro-financial imbalances, most notably high debt levels, which could thereby adversely affect the economy and financial system. Members noted that, as potential growth in China slowed over time, high levels of debt would become more difficult to service. More broadly, the policy environment in China had also become increasingly complex. However, members observed that because most debt in China was held domestically and policy decision-making was centralised, Chinese authorities had more scope than some other emerging economies to manage the pace of deleveraging in parts of the economy. In view of the limited extent of China’s direct financial linkages with Australia and other advanced economies, members noted that the effects of financial stress in China – were they to materialise – would be felt mostly via trade linkages and an increase in risk aversion in global financial markets.

Members discussed two other risks to global financial stability, outside of China, that were relevant to Australia. The first was the risk of a further substantial tightening in global financial conditions, accompanied by a disorderly repricing in markets for financial assets. Potential catalysts for this included persistently high global inflation, which would require interest rates to remain high for longer than currently expected, and/or a sharp downturn in the global economy. Events over preceding years illustrated that it was possible that vulnerabilities in non-bank financial institutions in key global financial centres could amplify abrupt adjustments in financial markets. If these adjustments were sufficiently severe, they could affect funding costs and access to credit in Australia.

Members also considered the implications of continued weak conditions in commercial real estate markets globally. The outlook for commercial real estate prices appeared challenging, given higher interest rates and ongoing weakness in rental demand. The office sector was assessed as being most vulnerable to further repricing. While stricter lending standards and banks’ strong capital positions meant international banking systems were more resilient than previously to such a deterioration, high exposures remained a concern among smaller US banks and some banks in northern Europe. There was also potential for stress in overseas commercial real estate markets to contribute to lower valuations in Australia through common ownership and funding sources, given the increased presence of international lenders and investors in Australian commercial real estate markets over the preceding decade or so. However, members noted that the risks to the domestic financial system were limited by Australian banks’ low commercial real estate exposures and conservative lending practices.

Members agreed that while the effects of inflation and interest rates were challenging for Australian households and were falling unevenly across the community, most households and businesses were managing to adjust. Strong labour demand and sizeable savings buffers accumulated during the pandemic had helped households to adapt to the increase in interest rates and inflation. Mortgage and business loan arrears had picked up, but only slightly. Most borrowers who had recently rolled off very low fixed-rate loans appeared to be adjusting to higher variable-rate loans. However, members noted that the outlook for the labour market remained critical to the resilience of households; more borrowers would encounter financial difficulties if the unemployment rate increased, particularly those with low savings buffers.

Economic conditions were also having an uneven effect on businesses in Australia. Ongoing cost pressures and the recent softening in demand had put pressure on some businesses’ profits and liquid reserves, most notably in the construction sector and the arts and hospitality sector. Corporate insolvencies had increased to around pre-pandemic levels, although most had tended to be small firms with little debt, limiting the wider effect on the economy and financial system.

Members observed that Australian banks remain well positioned to continue supplying credit to the economy. Banks are profitable and hold capital and liquid assets well above regulatory requirements, which puts them in a strong position to absorb increased loan losses if there were to be a substantial slowing in growth and an increase in unemployment. Only a very low share of housing borrowers are in negative equity on their loans, further protecting banks against credit losses, and the return of housing prices to around their peak has reduced this share even further. Members agreed that APRA’s regulatory regime means that Australian banks are well placed to manage the effects of interest rate volatility on their balance sheets. Banks have adjusted well to the roll-off of funding from the TFF, and their increased reliance on domestic deposits for funding since the global financial crisis has left them better placed to weather disruptions to international funding market conditions.

Members noted the importance of financial institutions continuing to strengthen their financial and operational resilience to threats arising from outside the financial system. Such threats include cyber-attacks, the potential for an escalation in geopolitical tensions that cause severe disruptions to trade and international capital flows, and the effects of, and responses to, climate change.

Considerations for monetary policy

In turning to the policy decision, members noted that inflation remained well above target and was expected to do so for some time. Services price inflation remained sticky, and fuel prices were adding to headline inflation. At the same time, members observed that the labour market had reached a turning point and output growth had slowed, albeit more gradually than previously expected. The tightening of monetary policy since May 2022 was still permeating through the economy and it would take some time for the full effects of this to be observed in the data. Market economists and financial markets were anticipating that the cash rate would be increased further, but not at the current meeting. Members also observed that, while there were clear risks to financial stability, these risks did not have a bearing on monetary policy at this meeting.

In light of these observations, members considered two options for monetary policy at this meeting: raising the cash rate target by a further 25 basis points; or holding the cash rate target steady.

The case to raise the cash rate target further centred on the outlook for inflation and the associated risks. Members noted that core services inflation remained persistent internationally. Domestically, the monthly CPI indicator suggested that progress in lowering services price inflation remained slow. It was noted that the rise in retail petrol prices would continue to underpin inflation over coming months and could influence households’ inflation expectations. Members acknowledged that upside risks were a significant concern given how long inflation is likely to remain above target.

Members also considered the implications of developments in asset prices for monetary policy. They noted that while rising housing prices alone would not warrant tighter policy, the associated rise in household wealth could support consumption by more than currently assumed, especially if housing turnover were to pick up more quickly than expected. The rise in housing prices could also be a signal that the current policy stance was not as restrictive as had been assumed, although there was other evidence that monetary conditions were tight. Similarly, members observed that developments in the exchange rate over prior months had eased monetary conditions, though only at the margin.

The case to hold the cash rate target unchanged at this meeting centred on the observation that interest rates had been increased significantly in a short period, and that the effects of tighter policy would not be fully evident in the data on economic activity and inflation for some months. At the same time, inflation had abated from its peak in December 2022, consumption growth was weak and households’ real disposable incomes were still falling. Also, the labour market had reached a turning point and the challenges in the Chinese economy could lead to slower growth in Australia if not contained. Members noted that these observations meant there remained a risk that output growth slows more sharply than expected; if so, it would bring inflation back to target more quickly than expected.

In weighing up these two options, members agreed that the case to leave the cash rate target unchanged at this meeting was the stronger one. They concluded that there had not been sufficient new information over the preceding month from economic data or financial markets to necessitate an adjustment in the stance of monetary policy. Members observed that, prior to the November meeting, they would receive additional data on economic activity, inflation and the labour market, as well as a set of revised staff forecasts.

In reaching their decision, members noted that some further tightening of policy may be required should inflation prove more persistent than expected. The Board has a low tolerance for a slower return of inflation to target than currently expected. Whether or not a further increase in interest rates is required would, therefore, depend on the incoming data and how these alter the economic outlook and the evolving assessment of risks. Members reaffirmed their determination to return inflation to target within a reasonable timeframe and their willingness to do what is necessary to achieve that outcome.

The decision

The Board decided to leave the cash rate target unchanged at 4.1 per cent, and the interest rate on Exchange Settlement balances at 4 per cent.